5 reasons consultants should consider incorporating

One of the biggest decisions facing consultants and freelancers is whether to incorporate or to continue being "self-employed" or a "1099" for tax purposes.

Incorporation has many benefits for small business owners, and here are five reasons why consultants should consider incorporating:

1. Limited personal liability

The classic reason for incorporating a business is to limit the personal liability of the owner; this is especially pertinent if you are the only member/employee of your business.

By incorporating, the owners' personal assets are, for the most part, off limits to satisfy judgments against the business, including any breach of contract allegations.

2. Potential tax savings

Some businesses can gain great tax benefits by incorporating, but this is an area that you and a tax professional need to examine closely before your decision.

For example, if you incorporate as an S-Corporation, which consists of fewer than 100 shareholders, you will pay income tax on your share of the corporation's income (wages, dividends, and taxable benefits paid to you by the corporation) at your personal tax rate; you can also use corporation losses to offset other income.

The S-Corporation itself is unlikely to pay any direct income taxes. C-Corporations, on the other hand, pay a flat 35% tax rate, so be very careful about how you set up your corporation.

Remember that if you are self-employed, your income is subject to income tax as well as the self-employment tax.

Another way you can save on taxes through incorporation arises because small business retirement plans allow for the deferral of a larger percentage of income. In other words, through incorporation, you can maximize your retirement fund contributions, which reduces your taxable income and therefore the amount of taxes due.

3. Reduced chances of tax audit

Self-employed taxpayers who are required to file a Schedule C have one of the highest audit rates; the government apparently believes that many self-employed individuals underreport income and overstate deductions, so this is the IRS's way to find them.

Yes, the chances of being audited by the IRS are already relatively low, but just by incorporating your business, you are lowering them even further.

4. More affordable health insurance

One of the biggest expenses—and often one of the first to be cut from the budget—for consultants and freelancers is health insurance. Through incorporation, your company may be eligible to purchase medical and dental plans at a discount.

Moreover, you may also be able to get a medical reimbursement plan for expenses not covered by insurance. Although additional medical expenses may be deductible for the self-employed, i.e., unincorporated, taxpayer, remember that the deduction is limited to amounts in excess of 7.5% of adjusted gross income, which can be a fairly high threshold for some taxpayers.

5. Increased credibility

Having an "Inc." or "Co." after your business name instantly tells potential clients that, well, you mean business. You're not just running your consulting or freelance business out of your garage in your free time as a hobby—this is your career and livelihood, and your business name says so.

Incorporation adds a certain level of professionalism to your business and clients will take notice, especially those who would prefer to work "corp to corp" instead of collaborating with 1099s.

Disadvantages of incorporating

Incorporating isn't without its potential disadvantages. There are costs associated with setting up your corporation and the tax benefits don't apply to everyone. Talk to your financial advisor to make sure that incorporating makes sense for your business.

Overall, though, incorporating can be one of the best business decisions many consultants and freelancers ever make.